Tax Exempt Status

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Having 501(c)3 status from the IRS can really help with donations. Being a 501(c)3 requires that all assets and income of your organization be dedicated irrevocably to your mission. It also specifies at least a minimum amount of transparency and reporting. This can make donors feel more secure that their donations will go to support your charitable mission.

It's easy to be a non-profit, you just file the paperwork with your state. However, 501(c)3 status can take months to get.

So, if your donors want to be sure that you are using their donation for your mission, they might like to have a statement in your articles of incorporation that you're going to act like a 501(c)3 even if you don't have that status with the IRS.

In some states your articles of incorporation bind you to act like a 501(c)3 even if you don't have that certification. For instance, in California the standard non-profit articles include:

  • This corporation is organized and operated exclusively for the purposes set forth in Article 4 hereof [the purpose statement in your articles of incorporation] within the meaning of Internal Revenue Code section 501(c)3.
  • The property of this corporation is irrevocably dedicated to the purposes in Article 4 hereof and no part of the net income or assets of this corporation shall ever inure to the benefit of any director, officer or member thereof or to the benefit of any private person.
  • Upon the dissolution or winding up of this corporation, its assets remaining after payment, or provision for payment, of all debts and liabilities of this corporation shall be distributed to a nonprofit fund, foundation, or corporation which is organized and operated exclusively for charitable, educational and/or religious purposes and which has established its tax-exempt status under Internal Revenue Code section 501(c)3.

501(c)3 Fiscal Sponsor

A fiscal sponsor is when a charity with 501(c)3 status accepts donations and in turn uses them to sponsor a non-profit project that does not have tax exempt status. Lots of non-profits do this. You have to find a charity that has a mission that aligns with that of your non-profit. It turns out that some charities have very broad missions specifically designed to encourage new non-profits. Signing on with one of these fiscal sponsors is easy and lets you take tax deductible donations in about a week. Wow, just what you need! BUT, there are some things to consider...

There are two common models of fiscal sponsorship.

Model A

The project (your organization) is not a separate legal entity. Your project is completely absorbed by the sponsor. The sponsor does accounts payable. Employees are employees of the sponsor. The sponsor signs any lease for a building. Assets belong to the sponsor. Shop membership dues would go through the sponsor. The sponsor provides insurance. The sponsor is, in fact, responsible for the actions of the project. While your project is run by the project board, the sponsor keeps final control of all decisions because they are responsible. Your project might want to do a "build-your-own personal helicopter and fly it with us" event; the fiscal sponsor might say you can't do that. A sponsor might take 8% of all donations.

Model C

The project (your organization) is a separate legal entity. The sponsor collects money and makes grants of that money to the project. The relationship is grantor to grantee. The grantee has to report back to the sponsor how every penny of the grant is spent and has to periodically report on activities performed and success of the project, just like you would to anyone who provides a large grant. You have your own employees, accounting, taxes, insurance, etc. Your assets remain belonging to your legal entity. Membership fees, sub lease rents, etc do NOT flow through the sponsor and you get to keep all of that money in your organization.

The sponsor sets up a pre approved grant agreement. Donors give money to the sponsor to be used to fund the project. If the sponsor ever felt that your project was not acting in good faith to accomplish your non-profit mission, they would revoke the grant and keep whatever money had not been disbursed. One sponsor takes 6.5% of all donations for this. Credit card fees are on top of that.

On grant proposals the grantee of record would be the sponsor with the project being your organization. The grants would be made to the sponsor.

Most donors are ok with a fiscal sponsor, some are not. For example, Google gives free use of the apps suite to 501(c)3's. If your fiscal sponsor is already using Google Apps, Google will not recognize your organization for use of their apps for free.

When/if you eventually get your own 501(c)3 status it should be easy to split off as long as your mission remains the exact same as it was when you signed up with the sponsor.

Questions to ask

Once money is donated to the sponsor, how soon is it available to you. A maximum should be within 7 days, typically within 72 hours.

Does the sponsor provide any additional resources to your organization? Discounts on human resources, accounting services, software, crowdsourcing, etc.

Other Resources

Here's an interesting paper on Fiscal Sponsorship. One extract:

"However, the IRS has a strict policy against “conduit” arrangements. When a donation is made by A to B, earmarked for C, it is in reality a donation from A to C, and if C is not exempt under section 501(c)(3), the gift is not a tax-deductible contribution. To be deductible, the IRS requires that B (the sponsor) have complete discretion and control over the funds, and holds B legally responsible to see that its payments to C (the project) are made to further B’s tax-exempt purposes."

Here is an excellent video of a talk by a lawyer who does pro bono work for non-profits. It is very informative - worth the hour to watch it.